Forex Correlations (July): How Do Currencies Move In Relation To Each Other?

[DailyFx]

Over the past month, volatile risk fluctuations have settled and put the focus back on the theme of the US dollar against all its major counterparts. This is largely a reflection of the importance of growth (as the US is the largest economy in the world and is therefore expected to pace a recovery) and the greenback’s position as the world’s reserve currency.



The following is our monthly correlations update for July. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation for the majors against the EURUSD for a different view of correlation.

In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. For example, having a portfolio that consists of the EURUSD and AUDUSD is different than having a portfolio comprised of EURUSD and USDCHF. Over the past month, volatile risk fluctuations have settled and put the focus back on the theme of the US dollar against all its major counterparts. This is largely a reflection of the importance of growth (as the US is the largest economy in the world and is therefore expected to pace a recovery) and the greenback’s position as the world’s reserve currency. With the dollar taking its place as the universal counterpart once again, we have seen the USDCHF ease its correlation to general risk appetite and aversion and take up as the counterpoint to EURUSD once again (-0.91). The same would happen as much for the yield heavy pairs as the anemic. Like EURUSD, AUDUSD holds a significant interest income; yet it is clearly the dollar’s influence guiding this pair as the shifts in correlation have changed little from last month (0.76) to current levels (0.74). From a trading perspective, this means that having long exposure in both EURUSD and USDCHF would offset much of the profit or loss that could be derived by holding a single position because when EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. On the other end of the scale, holding long EURUSD and AUDUSD positions would be akin to nearly doubling up in one of the pairs since the correlation is positive and strong.

Furthermore, we can tell from our tables correlations rise and fall through different periods. There is clear evidence from the month to month changes of the correlation that risk influences are shifting. Comprised of two sensitive currencies, USDJPY will only track the changes in more ‘exposed’ currency pairs when the shifts in risk appetite are extreme. This is why USDJPY has seen its one-month link to AUDUSD drop so sharply (from 0.63 to -0.17) from June first to July first. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios over time.

Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

FX Correlations (data as of 07/01/09)







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